Alex Ntelekos calls for closer ties between actuaries and catastrophe modelling
In my professional experience so far, I have had ample chance to interact with actuaries. As a matter of fact, and as strange as it may sound to the outside world, I am very proud to say that some of my best friends are actuaries.
Coming into this industry about five years ago, knowing little about the actuarial profession, I was not sure what to expect in terms of the knowledge and expertise of actuaries. I was quickly impressed by their statistical skills, their keyboard-only use of Excel and their tremendous appetite for numbers, formulas and quantitative analysis, not to mention their high working standards.
However, one area that the profession didn't seem as connected to was that of catastrophe modelling. As catastrophe risk is a major driver of risk for non-life (re)insurers, I would have expected most actuaries to be true experts. This has not always been the case.
Actuaries typically appreciate the intricacies of the calculation of an event loss table or a year loss table. They know how to perform Monte Carlo simulations to produce distributions and apply reinsurance terms. However, they usually stop short of further in-depth knowledge of catastrophe models. In true actuarial style, I have narrowed down the reasons for this to three components.
> Black-box mentality: cat models are complicated beasts. In the same way that fine art or classical music are perceived by some to belong to a closed elite, cat models are thought to be understood only by the few and the proud. The underlying physical processes driving these models require some formal training to understand, and the models themselves are too proprietary to be straightforward.
> The focus of the Institute and Faculty of Actuaries (IFoA) training: this has not traditionally included catastrophe risk or models as a separate subject. This is, to a certain extent, a direct consequence of black-box mentality - in contrast, there is a greater focus on economic scenario generators, where transparency is perceived to be higher. However, it does not explain all the variance. Actuarial students are being exposed to an array of subjects, but the visibility of catastrophe risk is relatively low, compared with its overall importance, and it is usually treated as part of insurance risk.
> Organisational structure: insurance and reinsurance companies may keep actuarial teams isolated from the business. Although this ensures a degree of independence and challenge, when overdone it hinders ability to make meaningful contributions.
The overall ability of the insurance industry to challenge and understand catastrophe models has increased during the past 10 years. Cat modelling vendors have become more transparent and documentation quality has improved. Regulatory requirements are calling for more openness and challenge around catastrophe models. An increasing number of academics are interested in cat models and open architecture platforms have been launched. The world of cat modelling is opening up and black-box mentality will be démodé.
In my view, the IFoA will quickly respond to the challenge and increase the visibility of cat models within its curriculum. Extensive exam questions on cat modelling appeared after a major update of one of the vendors in 2011. This recognised the fact that cat models are becoming essential in the management of catastrophe risk within firms. It would only benefit future actuaries if the curriculum more explicitly recognised catastrophe risk as a separate subject and if training were part of continuing professional development.
Last, but not least, firms should look to further embed the actuarial function into the cat business. As the industry moves towards a more technical and analysis-based approach, firms that bring actuaries closer to the catastrophe risk, aggregate management and underwriting team to cross-pollinate expertise are likely to be winners. Actuaries should also actively look to learn more about catastrophe risk. Opportunities for a secondment to the cat team, a training programme or a seminar can only be of benefit to an actuary's professional career and to the industry as a whole.
Alex Ntelekos is a technical specialist in the insurance division of the Prudential Regulation Authority (PRA), a subsidiary of the Bank of England